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U.S. Markets: Is Gold Signaling a Top in the S&P 500?

February 7th, 2012 · Chris Vermeulen · 6 Comments

Friday morning traders and market participants awaited the key January employment report from the U.S. Bureau of Labor Statistics. The reaction to the supposedly wonderful report was a surge in the S&P 500 E-Mini futures contracts as well as several other key equity index futures.

The overall tenor among the financial punditry was predictable as wildly bullish predictions permeated the morning session on CNBC and in the financial blogosphere. However, after the report had been out for several hours notable independent voices such as Lee Adler of the Wall Street Examiner came out with information that suggested the numbers were an apparition of manipulated statistics.

I am not going to spend a great deal of time discussing the report, but the reaction to the news was decisively bullish on Friday. The question I want to know is whether Friday was a blow off top? In the recent past the S&P 500 has seen several key inflection points and intermediate-term tops form on non-farm payroll monthly announcements.

I follow a variety of indicators to help me decipher more accurately when the market is getting overbought or oversold. For nearly two weeks the market has been extremely overbought, but now we are reaching truly astonishing levels. The following charts represent just a few signals that the market is due for a pullback and a top is likely approaching.

 

Percentage of NYSE Stocks Trading Above Their 50 Period Moving Average

The chart above clearly illustrates that as of Friday’s closing bell (02/03) over 89% of stocks were trading above their 50 period moving averages. Consequently that reading is one of the highest levels that we have seen in the past 3 years. In addition, over 73% of stocks that trade on the NYSE are currently priced above their longer-term 200 period moving averages. Another extremely overbought signal.

 

S&P 500 Bullish Percent Index Weekly Chart

The S&P 500 Bullish Percent Index is another great tool for measuring the overall position of the S&P 500. It is without question that the longer term time frame is reaching the highest level of overbought conditions in the past 3 years.

 

McClellan Oscillator Divergence with S&P 500 Price Action

The two charts shown above present an interesting situation regarding the divergence in the McClellan Oscillator and the price action in the S&P 500. The most recent example of this type of divergence occurred in October of 2011 and prices immediately reversed to the upside after several months of selling pressure. In fact, this correlation between reversals in the S&P 500 and divergences in the McClellan Oscillator works relatively well historically.

Clearly there are bullish voices arguing for the 2011 S&P 500 Index high of 1,370.58 to be taken out to the upside in the near future. Additionally, several market technicians in the blogospere have been pointing to the key resistance range between 1,350 and 1,370 on the S&P 500 as a likely price target. Obviously if those price levels are met strong resistance is likely to present itself. However, as a contrarian trader I have found that the more obvious price levels are the more likely it is that they either will not be tested or they will not offer significant resistance.

It is obvious that Chairman Bernanke and the Federal Reserve have embarked on a massive fiat currency printing campaign which has helped buoy risk assets to the upside. Through a combination of reducing interest rates on safety haven investments like Treasury’s and CD’s, the Federal Reserve has forced conservative investors and those living on a fixed income into riskier assets in search of yield.

This process helps elevate stock prices and creates the desired outcome for the Federal Reserve which involves the perception by average individuals that they are wealthier. The Fed calls this the “wealth effect” and they seem poised to insure that U.S. financial markets continue to ride upon a see of cheap money and liquidity.

Ultimately the Federal Reserve’s most recent announcements have served to help flatten the short end of the yield curve further while providing a launching pad for equities and precious metals. However, issues persisting in Europe could have an adverse impact on the short to intermediate term price action of the U.S. Dollar.

Right now everywhere I look I hear market prognosticators commenting on how hated the U.S. Dollar is and how Chairman Bernanke will not allow the Dollar to appreciate markedly in order to protect U.S. exports and financial markets. I think that the Dollar has the potential to rally in the short to intermediate term. Right now the U.S. Dollar Index appears to be trying to form a bottom.

 

U.S. Dollar Index Daily Chart

Obviously there is good reason to believe that the U.S. Dollar Index could reverse to the upside here. Whether it would have the strength to take out recent highs is unclear, but a correction to the upside not only seems unexpected by most market participants, but it seems plausible based on the weekend news coming out of Greece.

Monday morning the Greek government is set to determine if they will agree to the demands of the Troika in exchange for the next tranche of bailout funds. If the Greek government and the Troika do not come to an agreement, the Euro could sell-off violently.

Additionally there are already concerns about the next LTRO offering from the European Central Bank. The measure is to help provide European banks with additional liquidity, but there are growing concerns that the size and scope of the LTRO could have a dramatic impact on the Euro’s valuation against other currencies. Time will tell, but there are certainly catalysts which could help drive the U.S. Dollar higher.

Another potential indicator that the Dollar could see higher prices in coming days was the largely unnoticed bearish price action on Friday of precious metals. Both gold and silver have been on a tear higher over the past several weeks. Both precious metals have surged since the Federal Reserve announced that interest rates would remain near zero on the short end of the curve through 2014.

However, on Friday gold and silver were both under extreme selling pressure. The move did not get much attention by the financial media. The price action in gold and silver on Friday could be another indication that the U.S. Dollar is set to rally. The daily chart of gold is shown below.

 

Gold Futures Daily Chart

Obviously the reversal on Friday in gold futures was sharp. The move represented nearly a 2% decline for the session on the price of gold. However, as long term readers know I am a gold bull. I just do not see how gold and silver do not rally in the intermediate to longer term based on the insane levels of fiat currency printing going on at all of the major central banks around the world. The macro case for gold is very strong, but the short term time frame could reveal a brief pullback.

At this point, I suspect a pullback will present a good buying opportunity for those that are patient. However, I think it is critical to point out that this move in gold on Friday could be a signal that the U.S. Dollar is going to find some short to intermediate term strength. If the Dollar does start to push higher, it will likely put downward pressure on risk assets like equities and oil

While Friday’s price action may not mark a top, nearly every indicator that I follow is screaming that stocks are overbought across all time frames. Pair that with the Greece uncertainty and LTRO considerations and suddenly the Dollar starts to look a bit more attractive. Ultimately I am not going to try to pick a top, but the evidence suggests that it might not be too many days/weeks away.

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6 responses so far ↓

  • 1 GoWest // Feb 8, 2012 at 4:00 pm

    I wonder if the surge in gold and silver (and dollar drop) started when insiders knew Obama was going to indulge in +$500m more borrowings and printing over the next quarter.

  • 2 Greg Atkinson // Feb 9, 2012 at 8:47 am

    Maybe. Actually the gold price has been pretty confused right now. In the last few days I read a couple of articles which too very different view on the gold demand from China.

    One article basically said that the demand for gold in China will keep growing as the Chinese middle class grows and the government wants to own something besides U.S. dollars.

    The other article said that the surge in demand for gold in China should be seen as a warning sign. Firstly because it means people are losing confidence in the local currency & property plus plus it means the central government is nervous.

    Gold still hasn’t smashed though the $2000 USD an ounce level yet despite so much going for it. Perhaps it has already peaked?

  • 3 Pat Cox // Feb 9, 2012 at 3:21 pm

    Disagree Greg.

    Gold will peak around the time when all the following will be observed:

    -Gold will go past its inflation adjusted highs (which is over ~$2000).
    -The Dow:Gold ratio will be 1:1 (or close to) as it has in the last 2 times when the secular bull in gold ended (1932 and 1981).
    -The secular bear market in US equities will end around 2015-2017 with US equities at a single digit P/E multiple just like the last 2 secular bears ended. Currently, S&P500 is at 13x.

    Also while it might seem far-fetched and unreasonable to see gold at $5000 or $8000, that’s what parabolic ends to bubbles are. In the last 1 year of the gold bubble gold went up 3 fold in its final parabolic move.

  • 4 Stillgotshoeson // Feb 9, 2012 at 3:29 pm

    Pat Cox // Feb 9, 2012 at 3:21 pm

    -The secular bear market in US equities will end around 2015-2017 with US equities at a single digit P/E multiple just like the last

    100% agree with this time frame….. Volatility will continue with peaks and troughs a common theme for the next few years, but the trend will to be to continue downwards for some time yet.

  • 5 Greg Atkinson // Feb 9, 2012 at 4:58 pm

    I should have put my gold peaked comment into a time frame. I meant to say that gold may have peaked during this current cycle. I suspect at some point in time it will rise to $2000 USD an ounce but not during this current crisis. I reckon there is enough bad news priced into gold already so unless the USD tumbles then I can’t see gold in USD terms surging skywards.

    At the end of the day you have to have lots of investors with money who willing to buy gold with the aim of parking it in a vault and there is limit to how much they will pay for gold before they switch to other things to invest in. Gold is not the only show in town.

    Anyway I imagine we will find out soon enough where gold will be headed once we get some Q1 numbers for the Chinese economy. I think the extent of the slowdown there will surprise many people.

  • 6 Plornt // Feb 24, 2012 at 3:38 pm

    “Disagree Greg.

    Gold will peak around the time when all the following will be observed:

    -Gold will go past its inflation adjusted highs (which is over ~$2000).
    -The Dow:Gold ratio will be 1:1 (or close to) as it has in the last 2 times when the secular bull in gold ended (1932 and 1981).
    -The secular bear market in US equities will end around 2015-2017 with US equities at a single digit P/E multiple just like the last 2 secular bears ended. Currently, S&P500 is at 13x.

    Also while it might seem far-fetched and unreasonable to see gold at $5000 or $8000, that’s what parabolic ends to bubbles are. In the last 1 year of the gold bubble gold went up 3 fold in its final parabolic move.”

    Great post Pat. I agree with that wholeheartedly. You’ve done your homework. If you study the cycles from 1780 onwards you can also see that Gold and Silver have a lot of room to run. I plan to sell my silver at 300$, but it will probably go higher than that. Can also see Oil to 500$ as a possibility in 5-10 years. There is 8 years left in this supercycle based on the secular commodity cycles.

    I think the main moves in precious metals might be if we see UK bond markets or even US bond market bubbles implode, and there is a flight to safety. Cash and Bonds are in grand daddy bubbles !

    Here is a very intelligent chap on the cycles:

    http://www.viddler.com/v/ff125b8

    This drivel should not be taken as financial advice. Seek to obtain professional
    advice before proceeding with any financial decision.

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